US refining margins improve, but some refineries remain at risk
During the fourth quarter of 2010, US refining industry performance improved relative to the prior quarter. While the US Gulf Coast crack spreads were somewhat lower in the fourth quarter, the light-heavy crude oil price differential (LLS-Maya) continued to favor refineries with heavier crude slates. January 2011 indicates a continued widening of the light-heavy spread and improved crack spreads.
Baker & O'Brien, Inc.'s fourth quarter 2010 release to PRISM subscribers indicates that overall 2010 margins are higher than in 2009, with US fourth quarter 2010 cash margins improving in every district. When compared against the previous quarter, refinery cash margins have risen, on average, $1.20 per barrel. Bucking the trend was PADD 4 (see the bottom of this article for PADD definitions), which showed a decrease of nearly $3 per barrel, reversing last quarter's improvement relative to other PADDs.
Some refineries have experienced very favorable market conditions recently. Refineries running WTI (and similar quality grades that are priced against WTI) have benefitted from historically low prices relative to LLS and other waterborne imports of light-sweet grades (prices that are Brent-based). Coking refineries have enjoyed respectable light-heavy spreads. Refineries in a position to export refined products have benefitted from an uptick in exports, driven by opportunities to supply Latin America and Europe. However, crack spreads generally remain low, keeping some US refineries at risk.
Further darkening some refineries' long-term prospects are the potential costs of consent decree settlements yet to be reached with the US Environmental Protection Agency (EPA). Since 2000, the EPA has entered into settlements with refiners to reduce air emissions under the Clean Air Act. In January, the EPA reached an agreement with HOVENSA resulting in penalties of more than $5 million and requiring significant investments in pollution controls. In addition, this agreement was most likely the cause of the announcement that a portion of the refinery will be shutdown and the refinery's crude oil processing capacity will be reduced. The investment required for the 104 refineries that had settled through 2010 was expected to top $5 billion, an average of more than $50 million per refinery.
Refineries representing more than 10% of US crude capacity are not yet under a consent decree with the EPA. The median capacity for these remaining refineries is less than 70,000 bpd and more than half of them process a light crude slate and operate a fluid catalytic cracking (FCC) unit, one of the four key “problem areas” identified by the EPA. Considering Baker & O'Brien's refinery viability factors, which include PRISM cash margin estimates that place 35% of these refineries in the fourth quartile, many of the refineries that have not been included in an agreement may already be at risk.
Even if refinery owners reach an agreement with the EPA, the expected costs of repairs, controls, and testing could be very significant. For some refiners, it might not be a question of negotiating the best agreement, but whether they can afford to operate with any agreement at all.
*PADD: Petroleum Administration for Defense Districts
PAD District 1 (East Coast) is composed of the following three subdistricts:
Subdistrict 1A (New England): Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont.
Subdistrict 1B (Central Atlantic): Delaware, District of Columbia, Maryland, New Jersey, New York, Pennsylvania.
Subdistrict 1C (Lower Atlantic): Florida, Georgia, North Carolina, South Carolina, Virginia, West Virginia.
PAD District 2 (Midwest): Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, South Dakota, Ohio, Oklahoma, Tennessee, Wisconsin.
PAD District 3 (Gulf Coast): Alabama, Arkansas, Louisiana, Mississippi, New Mexico, Texas.
PAD District 4 (Rocky Mountain): Colorado, Idaho, Montana, Utah, Wyoming.
PAD District 5 (West Coast): Alaska, Arizona, California, Hawaii, Nevada, Oregon, Washington.
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